What does cost externalisation mean? A short introduction.

“Cost externalizing is a socio-economical term describing how a business maximizes its profits by off loading indirect costs and forcing negative effects to a third party.” – Wikipedia

When I started to take classes in economics back in 2006 I was taught that the price for a good or service is being determined by the interaction of demand and supply. The equilibrium point showed how much a person had to pay if he needed or desired something and how much someone had to earn to pay for the raw materials, employees, other operating costs and to earn a living for himself.

When Kant wrote his publication “Perpetual Peace” in 1795/96 he stated that constitutional democracies would be more peaceful because they would have to carry the outcomes of their decisions. And actually most if not all of the wars since then, took place between or against non-democratic states or by one party externalising the costs on regionally restricted areas and their population (Iraq war). The thoughts of Kant that decisions are being made accounting for the possible outcomes and that these are more beneficial to common good, the more the decision maker has to stick to the resulting consequences, are very precious in the development of today’s society.

Applied to the economic system of our decade we can definitely say that a cost-by-cause principle, and hence the fact that who is responsible for a cost shall pay for it, would make the cohabitation way more peaceful. The actual maldevelopment does not reflect itself in form of wars but more in a negative attitude of a majority versus a minority and in daily problems of life like poverty, starvation and homelessness. The externalisation of costs is therefore undermining a happy, wealthy and healthy society.

Driven by the insatiable desire of wealth, neoliberal policy and the missing knowledge of how to identify and allocate external costs, the business world has developed the common and widely accepted mechanism of only calculating the microeconomical costs when assessing the price of their goods and services. And this behaviour is being accepted by a majority of buyers and consumers and even required by investors and shareholders in form of diligent value cretion.

Additional- and follow-up costs are deliberately shifted on nature, society, to other parts of the world or the future. The industry leaves behind the risks of nuclear technology usage, the costs of storing nuclear waste for centuries, CO2-emissions causing climate change with all the attached risks and damage or the destruction of landscapes. This makes consumers to unintended complies responsible for death and destruction, misfortune and poverty.

At the end, the price we are paying for a litre of gasoline is not covering the whole costs caused by our necessity and desire of individual mobility. All kind of prices are being distorted and the decision making of people, which is based on their knowledge, but mostly driven by financial aspects, is altered. How many people would actually rethink if a car is really needed for the 4 kilometres journey to work, if gasoline would cost 2.50€ per litre? Prices have a perfect allocative function, and companies have to protect their prices from the internalisation of the costs and risks they are causing. Additionally, politicians use this phenomena to keep people happy by keeping their life going on as usual (I have the feeling people like this morphine-addicted state of mind) and to protect the interest of companies which without doubt are necessary for employment and economic viability. A vicious cycle.

To restore an ideal decision-making basis for all market participants and to reduce the negative effects decisions of others can have on the society, no matter which or when, external costs caused by different business activities have to be identified and the perpetrator has to internalise them into his expenditures. Not only will this make us rethink our exorbitant consumption of goods and services but also will it make us buy the better products, since the cheaper ones are more likely to be those causing less external costs and hence damage.

Moreover, the government’s function of steering and aiding industries and companies through grants, tax remissions and other subsidies should be made way more transparent to the public. This will make it easier for people to control who is receiving their money and which products or services are actually costing more when considered completely. The population would then make sure to vote for those parties who will use their tax money in the way they want to help industries. A good example for this situation would be the wish to reduce the subsidies for the fossil energy sector and to invest the money into innovative renewable power sources.


The individual decision would then finally make even more sense than now.



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